Makhlouf argues against relaxing the debt target
By Richard Harman (author)
Treasury Secretary Gabriel Makhlouf has set out the argument against relaxing the debt targets from their current 15 to 25 per cent.
Since Labour took office, it has come under sustained pressure, particularly from the union movement, over its adherence to tight debt targets.
CTU economist Bill Rosenberg said back in May when the Government increased the debt limit from 2023 by five per cent that there was no point in having exceptionally low levels of debt and government spending when Kiwis were living in poverty, the health system was failing in important ways, working people and businesses were crying out for better education and training, and the environment was deteriorating.
“It is neither prudent nor responsible to privilege exceptionally low debt levels over major social, human, environmental and economic needs," he said.
“We urge the Government to make more use of its borrowing ability the build the productive and social assets our country needs, and to also signal a move towards the greater spending that is required to address New Zealanders’ needs.
“These can be done while remaining prudent fiscal managers.
"National, on the other hand, appeared not to understand that the new limits would not apply until 22/23, and its Finance spokesperson Amy Adams said the decision would mean billions of dollars more debt because the Government couldn’t manage the books properly and wanted to spend up on “big wasteful promises” in election year.
What both reactions show is how much the loan limits have become a political football.
Yet, though he may be embattled and under State Services Commission investigation over his reaction to National's obtaining Budget secrets out of Treasury’s computer system, on Friday Makhlouf set out in some detail how much the limits were at the heart of economic policy and how they overflowed into fiscal policy.
He said there was a debt/GDP ratio which if it was high enough, a debt crisis would occur.
As a consequence, Treasury thought that for New Zealand an upper limit of debt/GDP of around 50 – 60 per cent of GDP before the country risked a debt crisis.
However, Treasury proposed to the Government that, i.e. needed a buffer of around 20 per cent.
He said the GFC and the Canterbury earthquakes lead to debt increasing by 20%.
“This has informed our advice, both to this Government and its predecessor, that 20 per cent of GDP reflects a reasonable minimum buffer based on historical experience with past shocks,” he said.
It still places debt at the outer levels of political acceptance in New Zealand; In 1990, Treasury’s brief to incoming Finance Minister, Ruth Richardson, warned that net debt was at 51.7 per cent--- well above the-then OECD average of 31 per cent.
Makhlouf warned that there were hidden costs associated with the way debt was managed. Debt was taken on by other parts of the public sector that was not included in the ratio and the National Government's austerity programme after the earthquake carried its own costs.
“The Natural Disaster Fund was drawn on; contributions to the Super Fund suspended, and tighter limits were placed on government spending,” he said.
“Though these actions may have helped us limit the impact on net core Crown debt, they have also stored up some costs for the future, which should be accounted for when we assess the impact of shocks.”
However, Makhlouf rejects the argument that debt should be increased now because interest rates are low and emphasised the need to maintain a buffer.
He said this was particularly important because of the lack of room the Reserve Bank would have to lower interest rates during an economic shock and that therefore, stimulus would have to come from fiscal measures.
“This buffer for fiscal policy to respond to a shock is especially relevant in the current context of low-interest rates.
“ Although low-interest rates reduce the cost of borrowing, they also constrain the ability of monetary policy to respond to a shock.
“During the last global economic shock, the Reserve Bank reduced the Official Cash Rate by 575 basis points.
“With the OCR currently at 1.5 per cent, monetary policy does not have space for a similar adjustment without entering the territory of unconventional monetary policy.
And currency depreciation, the other usual mechanism for short-term macroeconomic stabilisation, will probably not be sufficiently stimulatory in a synchronised global downturn.”
So though Makhlouf's argument suggests an upper debt limit of 30 per cent –that is 10 per cent above where it is now and 5 per cent above where it will rest post-2022.
So why shouldn’t the current limit be raised?
“A net debt buffer of at least 20 per cent of GDP is required to respond to a range of shocks.
“A government particularly concerned about future uncertainties and risks may wish to maintain a larger buffer as an insurance against these costs; that would lead to setting a threshold for debt below the 30 per cent.
“Depending on the relative weight one places on the wellbeing of current or future generations, maintaining lower debt today may be a worthwhile choice to ease the impact of climate and demographic change on future generations of New Zealanders.”
In other words, Makhlouf is pointing to future governments potentially facing higher costs because of climate change and rising healthcare and superannuation costs.
He said those issues presented difficult choices "whether those obligations should be met by current or future taxpayers, and whether the level of entitlements today’s retirees enjoy should continue for future generations.
“I don’t raise these questions to propose a solution but only to emphasise that we should remain cognizant of these future challenges in our judgements today," he said.
“Perhaps all these costs can be met by future generations when they arise.
“Perhaps future governments can support the living standards of New Zealanders through this transition with higher taxes, or higher debt for the generation after them. “Or, perhaps current taxpayers should bear some of the burden of these future costs.
“These are difficult judgements.
“They concern the distribution of resources between generations and across society, as well as judgements about how much we should insure against these unknown future costs.”
In essence, Makhlouf underlines the perpetual political question about debt' every dollar raised today has to be paid back by a future generation.
But with a political system that is skewed towards short term answers, the answer to that question is distorted.
"We recognise there is a risk that some may read the 20% of GDP debt buffer as being the same as a 20% of GDP target. Gabs is arguing that the 20% of GDP is the amount we should buffer below the maximum limit of 50% to 60% of GDP, to allow debt to rise in the event of a shock, without reaching the welfare reducing level of 50% to 60% of GDP described in the second part of the speech. This leads to the upper limit of 30%, which government may choose to go further below because of the risks you mention in the article, as well as the capacity constraints discussed in the fourth part of the speech. The below diagram is helpful in explaining the construction of the 30% limit (the orange line) and the role of the 20% buffer (the light blue section).
“So where does that leave us? What is a prudent level of debt? As a starting point, the Treasury’s view is that an upper limit on net core Crown debt should be 50 to 60 percent of GDP, and that in addition to that, a buffer of at least 20 percent of GDP should provide a safety margin below that. Taken together, that would suggest a prudent debt limit of around 30 percent of GDP, but a government must also make the judgement over how far it wishes to self-insure and prepare for future fiscal risks today. And further, whether raising new debt today, rather than tomorrow, is an efficient and effective use of the Crown’s balance sheet. All these considerations may well lead to setting the debt anchor at a lower level. And they formed an important part of the Treasury’s advice that supported the Minister of Finance’s announcement of a net core Crown debt range of 15 to 25 percent of GDP.” (Material supplied by Treasury)